- SMSF trustees can choose between two methods when it comes to holding assets
- Funds where income-producing assets are pooled together are considered 'unsegregated' SMSFs
- 'Segregated' funds will have assets and the income from them allocated to certain members
Self-managed superannuation funds (SMSFs) in Australia can have two structures, where assets are either pooled or segregated.
What is a pooled SMSF fund?
A 'pooled' or unsegregated SMSF is where multiple members share one asset pool. This is the default SMSF set-up and, as such, these funds are by far the most common as well as generally being easier to administer.
What is a segregated SMSF fund?
A segregated fund has separate sub-accounts for each super fund member or separate asset pools within the fund. Around three in four SMSFs in Australia have multiple members but of these, only a small number are segregated funds.
Why do people segregate their SMSFs?
There are a couple of reasons an SMSF may choose to segregate assets within the fund. One is that some members may have different risk tolerances or preferences than others and may want to ringfence particular investments within a fund for their own purposes or needs. This can be appealing to some members as they are reaching pension phase and want to segregate more stable assets they believe will provide them with steady retirement income.
The other big reason is for tax purposes. Generally, tax on SMSFs can be split into two buckets:
- ‘accumulation’ where income and gains are taxed at 15%
- ‘retirement’ (also known as pension phase) where income and gains are generally tax-free
Segregating assets and income streams to sub-accounts may better cater for some members' individual needs in retirement and can also reduce overall tax payable (but, as you can imagine, the Australian Taxation Office has strict rules around this).
How do segregated/unsegregated tax methods work?
- Under the segregated method, funds can designate an asset solely into the retirement bucket, identifying it as a segregated current pension asset. It means any income derived from that asset (e.g. dividends, rental income, etc.) is exempt from tax. Regulations have made this more difficult over the years, but some may still use this method.
- Conversely, unsegregated or pooled SMSFs do not require specific assets to be separated or designated as solely for retirement income purposes. Rather, a proportion of all the fund’s income will be deemed tax exempt, representing the proportion of the fund's income that is supporting those in pension phase.
This set-up is often referred to as the proportionate or actuarial method as the fund will need to appoint an actuary to provide an actuarial certificate that determines what proportion of an SMSF’s earnings are supporting members in pension phase. Tax is calculated accordingly.
Unsegregated method example
An actuary determines that, over the year, an average of 70% of the fund’s balances were supporting retirement-phase income streams. In that case, 70% of the fund’s capital gains and income will be exempt from tax, while the remaining 30% will be taxed at 15%.
Other tax implications: capital gains tax
- Capital gains are also treated differently between the segregated and unsegregated methods. Under the segregated method, capital gains and losses on segregated assets are ignored in a tax sense, attracting no capital gains tax. However, a loss on a segregated asset can't be used to offset other gains within the fund.
- But if you’re using the unsegregated method, net capital gains (i.e. gains minus losses) are included as part of the fund’s assessable income. However, the fund can claim the Exempt Current Pension Income (ECPI) proportion (this is where the actuarial certificate comes in) to exempt the pension-backed portion of the gain. Net capital losses are carried forward to future years until they can be offset against a net capital gain.
Segregated vs unsegregated funds: Comparison
Here's a summary of the main differences between the models:
| Unsegregated | Segregated | |
| Structure | Assets are pooled | Assets are allocated according to a member's choice or status in fund (accumulation or pension) |
| Admin | Generally easier to manage | Entails more compliance and additional management |
| Claiming tax exemption | Actuarial certificate needed to claim permitted pension phase tax exemption | No certificate required (unless fund was segregated for only part of the year) |
| Capital gains tax | Net capital gains are part of the fund's income, less proportionate pension phase exemption | Any capital gain or loss on a segregated pension asset is disregarded with no tax payable |
Pros & cons of segregated SMSFs
While pooled funds are the default in Australia, there are some advantages and disadvantages to weigh up in deciding whether to pursue a segregated structure:
Pros
- Clear separation: Investment choice or performance of one member does not affect the balance and returns of other members
- Tax benefits: Assets supporting retirement phase pensions can be isolated and free from any tax
- More control: Individual members can have more control over their assets and investment choices within the fund
Cons
- More complex: Tracking of individual assets and their cash flows is required, requiring extra administration, management, and fees
- May limit fund to smaller assets: Splitting the fund's assets into smaller blocks may prevent the fund from investing in larger assets, such as property
- Rules for eligibility: The ATO applies strict rules regarding tax exemptions that need to be observed and managed as the fund evolves
When is there no choice?
There are some instances where funds may have no choice but to use the unsegregated method, such as having a pool of what are called ‘disregarded small fund assets’ in their portfolio. This will prevent the SMSF from being able to use the segregation method and force them to use the proportionate method.
The SMSF’s assets could be deemed as disregarded small fund assets if:
any time during the income year, the SMSF had at least one retirement-phase income stream (i.e. the SMSF wasn’t 100% in accumulation phase), and
a member has a total superannuation balance exceeding the $1.6 million cap, and
that member is also receiving a retirement-phase income stream, be it from the SMSF or another super fund.
However, if the fund has no disregarded small fund assets and is in 100% retirement phase for the entire year (i.e. there are no accumulation accounts), the ATO considers all the fund's assets to be ‘segregated current pension assets’, so the segregated method applies.
What if the fund isn't 100% in retirement phase?
If the fund isn’t in 100% retirement phase and doesn’t have disregarded small fund assets, it may have the option to use either method for calculating ECPI.
Savings.com.au's two cents
The segregated method of calculating how much of an SMSF’s income is exempt from tax arguably offers more tax benefits than the unsegregated method, although many funds are restricted to only using the latter.
If your fund is eligible, the decision to segregate assets should be carefully considered according to the fund's investment strategy, member needs, and individual circumstances that may see one method being more beneficial than the other.
As with many things SMSF-related, it’s highly recommended you seek professional advice before making any major decisions - especially if most of this article didn’t make any sense.
